Friday, June 20, 2008

Recently there have been two discussions of a possible market crash. The first warning comes from the Bob Janjuah, the credit strategist at RBS. The second is a more nuanced discussion coming from Todd Harrison, who writes at Minyanville.

The chance of a Market Crash is unlikely. Understand that Market Crashes are tail (low probability) events. Even if we accept that stock returns are not normally distributed but have fat tails, even fat-tailed events are still relatively low probability events.

Market Crashes occur because of the Wily Coyote effect. (Remember when he runs off the cliff in the Roadrunner cartoon, looks down and realizes that there is nothing beneath him?) In order for that to occur, investor sentiment needs to be fairly sanguine. Given that we have had two discussions of a possible Market Crash within the space of a week and the most recent AAII sentiment survey readings are now in the bearish territory (contrarian bullish), it seems unlikely that Wily Coyote has stepped off that cliff.

All this doesn’t mean that the equity market can’t fall – it’s just unlikely to crash. I have been looking for a panic sell-off to mark an intermediate term bottom (see my recent post). Mark Hulbert reports that current sentiment readings, while bearish, isn't bearish enough for a capitulation bottom. This suggests a scenario where the market breaches its March lows and continues to decline.

3 comments:

Dude, when these banks really disclose the true extent of their write downs, you will see real panic. Investors won't be able to jump over that cliff fast enough. Within the next couple of months these banks losses will be exposed. It will be in the tens of billions. The market can't handle that kind of stress. It has been years in the making but this ship is sinking.

I don't follow Hulbert but I share your view of waiting for a panic event/climactic sell off to mark a bottom. I also don't think it will be a crash event. I think that many value managers in the fund space have fallen for value traps in the financials and we should see some shake outs there that should be bought. The gloom and Doom speak is increasing which is good for contrarian plays. I'm starting to watch the finacials for some long plays now which is a shift for me.Just started to read your blog, very nice and thanks for sharing

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Welcome to my blog Humble Student of the Markets. These are my observations and musings about the markets (mostly equities), hedge funds and investments in general.My experience has been a quantitative equity manager in US, Canada, EAFE and Emerging Markets and commentator on hedge funds and their returns patterns.

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